New hedge funds can bring bigger rewards—and risks: Study

Wednesday, 27 Nov 2013 | 2:59 PM ETReuters

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Wealthy investors may get more bang for their buck if they invest with brand-new hedge fund managers, but they must also have a strong stomach to tolerate potential losses, according to a study released Wednesday.

Data from research firm Preqin show that the average hedge fund manager who set up a firm within the past six years delivered average annualized returns of 8.80 percent in the first three years of trading.

That compares with a gain of 5.38 percent for new funds launched by established firms.

The average hedge fund has gained only about 6 percent this year, according to Hedge Fund Research, while the Standard & Poor's 500 index is up 27 percent.

"Our data show that as an investor you can generate outperformance by putting money with brand-new managers if you can tolerate the risk that goes along with it," said Tim Friedman, head of U.S. operations at Preqin.

One-fifth of new managers took losses in their first year of trading, and those losses tended to be steeper than declines at other funds, Preqin showed.

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"You have to put skin in the game as a new fund manager and show that your interests are truly aligned with the investors," Friedman said. New managers often take bigger risks, he added, which can explain the greater gains or losses.

With banks curbing their proprietary trading operations and more junior partners at established funds itching to launch their own firms, the number of launches has never been bigger. This year, 231 funds have launched, putting it on track to beat 274 in 2012.

Richard Schimel, who once ran Diamondback, established Sterling Ridge this year, and Maverick Capital alumnus Michael Pausic started Foxhaven Capital Fund. Hari Ramanan and Adam Ryan are spinning out of Eminence Capital with their own fund, too.

Despite the increased choice, investors are more nervous about taking the plunge with a newcomer. Preqin data show only 38 percent are interested in first-time funds, down from 42 percent a year ago.

"It can be a big risk to commit to potential future stars," Friedman said, noting that most big institutional investors still insist on a three-year track record.

Investors such as pension funds are far more likely to invest with a small manager than a new one, the data show, with 75 percent of those polled by Preqin saying they would put money with funds that have less than $500 million in assets.